Financial or commodities instruments may be traded in government regulated exchanges and cleared through regulated clearing monopolies such as the National Securities Clearing Corporation (NSCC) (for equities), the Options Clearing Corporation (OCC) (for equity options), or the Government Securities Clearing Corporation (GSCC) (for treasury bonds). In contrast, instruments for which no central clearing solution exists are traded “OTC” or “Over the counter.” OTC products are traded and settled through multiple independent venues, introducing settlement risk and therefore affecting the marketability of prices as a function of the credit worthiness of the participants. Because settlement risk varies by participant, different participants have access to different rates in an OTC market. For example, most debt instruments are traded OTC with investment banks that make markets in specific issues. If a customer wants to buy or sell a bond, he or she will contact the bank that makes a market in that bond and ask for quotes. Many instruments, including forwards, swaps, currencies, and other types of derivatives are also traded OTC. In these OTC markets, large financial institutions typically serve as dealers, i.e., market makers. In an OTC market, a fair price is typically defined by what a willing buyer will pay and what a willing seller will accept.
A market maker typically provides a pair of prices to its customers, i.e., bid and offer prices. The bid price is the price the market maker is willing to buy from a customer, whereas the offer price is the price the market maker is willing to sell to a customer. The bid price is typically lower than the offer price, providing a spread, i.e., profit for the market maker.
In an OTC market, a market maker may trade instruments traditionally, e.g., by phone, or electronically, e.g., using a service provider. A service provider, such as Currenex (www.currenex.com) or EBS (www.ebs.com), typically provides one or more electronic communications networks (ECN), i.e., trading exchange platforms, for market makers to trade instruments electronically in an OTC market. A market maker may deal in multiple platforms. Likewise, a service provider may support multiple market makers through multiple liquidity pools (also referred to as exchange platforms, exchanges, exchange markets).
Because it is difficult to continually assess the market price, a market maker can inadvertently provide an off-market price, e.g., a bid price that is too high or an offer price that is too low, which may result in significant loses for the market maker. Similarly, since the market price changes constantly for a given instrument based on prices provided by other market makers, an existing price may become invalid from the market price in time.
Currently, service providers do not validate the bid and offer prices for the market makers and do not notify the market makers of an invalid off-market price. Trading on such invalid prices may result in significant loses for the market makers. For example, if a market maker offers to sell one million euros (EUR) and receive dollars (USD) at rate of 1.1724 and the average of offer prices has jumped to 1.1728, the market maker may lose a significant amount of money when the 1.1724 offer price was not updated and a customer takes the low 1.1724 offer price.